The 4 Angel Investing Strategies

Exclusive access to hot deals, discovering founders, picking winners, and indexing the category

If you want to make a good return (20%/yr+) by angel investing in early-stage startups, these are the four strategies that I see working today:

1. Exclusive access to hot deals
2. Discovering founders
3. Picking winners
4. Indexing the category

I’m an investor in over a dozen startup funds including Shrug, Haystack, Susa, Ribbit, Chapter One, 2am, and Pioneer Fund. They all boil down to these four strategies.

1. Exclusive access to hot deals

If a deal is hot, most angels won’t even know that the round is happening until it’s closed. The investors who do know are crowding around, offering more money than the founders are seeking to raise. That’s why you need exclusive access. You need the company to do you a favor and take your money.

Why do hot deals make you money? Because as a rule, they’re worth more than the price you’re buying in at. Effectively, the founders have agreed to impose an artificial price control until the “round” is “closed”.

(I’m using scare quotes because these concepts have been obsolete since the invention of the SAFE note in 2013, but as of the time of this writing, investors are still LARPing. The whole concept of “access to hot deals” is a pet peeve of mine. It’s a value-destructive dynamic that doesn’t exist in properly-functioning markets like the market for public-company stock. When you like a public stock, you have the option to buy it immediately, no matter how hot it is.)

Who gets exclusive access to hot deals? Anyone who has name recognition for any reason: A well-known investor, founder or executive at a well-known company, popular blogger, podcaster, Twitter account, etc.

What about investors who can add value by giving business advice, helping with sales, product, design, marketing, etc? Technically, brand-name investors are just a subset of value-add investors because being associated with their personal brand is a type of value-add. But it’s hard for you to get into deals if you have a value-add but you don’t have a personal brand. After all, if you’re really that good at adding value, then founders would expect you to have established some name recognition for yourself.

How do you get exclusive access to hot deals if you don’t have name recognition or a personal brand? You can hit up your founder friends, or hit up anyone in your network who is connected to good companies— mutual friends of you and the founders, friends who work there, friends who have already angel invested, etc… you know, networking. If you have a small check, say $10k, it’s not a big deal for the company to take it if you’ve made any kind of connection with them. The key is realizing that getting your name on their radar as an angel investor is worthwhile before the hot round happens. Otherwise, if the round is hot, you won’t even know when it’s happening and you won’t realize when you’re missing the exclusive opportunity.

2. Discovering founders

Instead of fighting to get into other people’s deals, you can originate high-quality deals by discovering first-time founders who aren’t connected to the startup system:

• Founders from developing countries who want their share of economic progress
• Founders from low-tech industries who want to drive change
• Founders from big companies who want to go fast
• Founders from academia who want to make something people want

You’re scouting for founders who have the talent to lead $billion companies. You might even believe in them more than they believe in themselves, because they’re not calibrated about comparing themselves to others. They don’t have the experience of seeing their friends go on that journey.

In theory, these founders don’t need you. They’re promising enough that they could apply to YC, get accepted, and 12 weeks later be a hot deal that you can’t get into. But they probably don’t realize how straightforward it is to apply to YC when you have a promising startup idea and you can explain it clearly. And before they’re ready to write a good application, they could use your guidance about how to think about the business opportunity and how to emphasize the strong points of their team and idea. In the weeks before their application or their interview, they could use your guidance prioritizing their time according to the Lean MVP flowchart. Etc. In practice, you can definitely be helpful to the new founders you discover.

3. Picking winners

When an early-stage deal comes your way, how skilled are you at recognizing signs that it has a serious chance (10%+) of becoming a $billion company? You don’t need to have an opinion on every deal. It’s best to focus on evaluating deals that you have some kind of advantage in understanding.

The problem with trying to pick winners is that either you know you can’t do it, or you think you might be able to do it but you don’t know it for a fact. You can’t expect your intuitive sense of whether you can pick winners to be reliable, so you won’t know the truth until you’ve made 100+ investments and waited 7+ years for the outcomes to play out. In the meantime, you should probably assume that you can’t pick winners, just like you can’t pick winners in the public stock market.

But if you can look at a stream of deals, and just notice when one of them has a strong chance of a huge outcome relative to its deal valuation, then your investments will have an attractive return — even if your dealflow is just mediocre! So if you want to focus on the picking winners strategy, you can just sign up to back a bunch of AngelList syndicates. You’ll get dozens of decent-quality deals emailed to you each day, and then it’s just a matter of picking winners.

4. Indexing the category

In the world of early-stage startups, there’s currently no single fund you can buy that gives you a market-average return, the same way that buying the S&P 500 exposes you to the average return of the US public stock market. But you can cobble together your own version of an index by investing into many startups and startup funds.

I believe the category of decent-quality early-stage startups is currently systematically underpriced relative to the S&P, even after you account for its higher volatility and lower liquidity. The reason is that most people who would want to put some of their money in any particular early-stage startup is currently prevented from doing so, because of multiple structural reasons:

1. Because of accredited investor regulations, most retail investors aren’t allowed to bid on deals.
2. Since there’s no central exchange for startup deals like the NYSE or Nasdaq, most deals never get matched with most investors who’d like to see them.
3. Early-stage companies typically only raise money via “rounds” of funding that usually happen less often than once per year. Fewer bidders can come to the table when the timing of the auction is limited.

So if you’re looking at a deal that’s had some pre-vetting by someone with a good track record, e.g. if you’re sourcing it from a reputable syndicate on AngelList, then on average (after making 100+ such investments), I believe you should expect to make a few % higher return on your early-stage startup portfolio than from investing that money in the S&P.

How to Get Started

If you see yourself as being good at one or more of these strategies, you should consider making investments and even starting your own fund or syndicate. I recommend Jason Calacanis’s book as a good introduction.

If you don’t see yourself as being particularly good at executing any of the strategies above, but you still want to allocate some of your personal investment portfolio into the early-stage startup asset class, you can use my 4-strategies framework to help judge whether investing in someone else’s startup fund has a good chance of making money for you.

A good default option is to invest in the AngelList Access Fund, which is good at indexing the category (#4), and probably decent at getting access (#1) and picking winners (#3). You can also research these AngelList rolling funds which are worse at indexing the category (#4), but claim to be better at some combination of exclusive access, discovering founders and picking winners (#1–3).

Note that investing in early-stage startups requires being an accredited investor, which means either having a certain level of income or assets, or taking an annoying test that requires about 60 hours of study.

Why Y Combinator Succeeds

Y Combinator, the best and most financially-successful early-stage investor in the world, succeeds because it nails all four of these strategies:

1. Exclusive access: YC has a great brand and offers many other value-adds. Early-stage founders take YC’s money even when they wouldn’t take money from any other early-stage firm, at least not on YC’s same terms.
2. Discovering founders: YC process applications from anyone who submits them systematically, objectively, quickly and at scale. If you’re an unknown first-time founder with a promising idea, there’s no faster and easier way to get $500k in your bank account than submitting a YC application. YC has discovered and empowered thousands of new founders this way.
3. Picking winners: This is actually the least-differentiated part of what YC does because they don’t have much secret sauce in how they evaluate applicants. Their public blog posts and videos pretty much cover how they do it. Their dealflow and scale allows them a healthy margin for error. Picking winners is still a core competency that YC is very good at and keeps working to get better at, but there are many individual angels who can do it equally well or better.
4. Indexing the category: At almost 1,000+ deals per year, they’re the best early-stage startup index in the world by far.

If you liked this post, check out the rest of my blog. Here are some recommendations:

• VC Larping
• The Lean MVP Flowchart: How to Follow the Value
• Sample Questions for the Y Combinator Interview

Follow me on Twitter @liron so I can get exclusive access to hot deals